Cocoa: A Sweet Portfolio

This Valentine's Day, some lovebirds will try to impress their sweethearts with something shiny from Tiffany's (NYSE:TIF). The rest of us will undoubtedly reach for the traditional box of chocolate. Approximately $285 million was spent on chocolate for Valentine's Day in 2010, and analysts estimate that this year could see as much as an 11% increase in sales.

A Cup of Hot CocoaMany of the same long term fundamentals that apply to silver, wheat and oil are also relevant to cocoa. Rising populations, coupled with new sources of demand, are having their way with prices. Overall demand for the soft commodity has continued to outstrip supply. This is now the fourth year in a row that there has been a major supply-demand disruption, and the last time cocoa experienced a shortage that lasting so long was in the 1960s. Analysts estimate that demand will exceed supplies again throughout the 2011 season - an event that has never happened in the 50 years of recordkeeping in cocoa market.

In the short- and medium-term, cocoa is facing a potentially tumultuous political situation. The Ivory Coast in Africa, which accounts for more than 40% of global supplies of cocoa and is the world's largest cocoa bean producer, is on the cusp of civil war. Elections held in late November had the Ivory Coast selecting a new leader in Alassane Ouattara. Sitting President Laurent Gbagbo, along with the nation's military, has refused to leave office. In an effort to remove Gbagbo, Ouattara has pledged a one month ban on all cocoa exports. The idea is hit the former leader where it hurts, namely the pocket book, and cause the military to expedite his release. The Ivory Coast has only seen relative peace since 2003 and could very easily erupt into a civil war, and any negative events in the nation could push cocoa prices even higher.

Adding Some Chocolate BarsWith both the long and short term fundamentals favoring the rise in cocoa prices, investors may want to take this often ignored commodity for a spin in their portfolio. The popular PowerShares DB Agriculture ETF (NYSE:DBA) includes an 11% weighting in cocoa futures, while the UBS E-TRACS CMCI Food ETN (NYSE:FUD) provides a 3% exposure. These broad-based funds are a perfect way for investors to play overall food price inflation. However, for investors just wanting chocolate exposure, there are other plays.

The iPath DJ-UBS Cocoa ETN (NYSE:NIB) offers a pure-play vehicle with regards to cocoa prices. The fund should to do well longer term, as demand continues to increase. Similarly, investors can play cocoas complement in sugar via the iPath DJ-UBS Sugar ETN (NYSE:SGG).

Hershey's (NYSE:HSY) represents one of the only pure publicly traded confectioners left on the market, and has been pretty successful at passing along rising commodities costs to consumers. The company also benefits from higher promotional pricing during the holidays. Shares of the chocolate giant yield 2.7%.

Finally, investors wanting to play the rise in chocolate and cocoa prices, can do so geographically. Switzerland leads the world in chocolate grinding, and saw sales rise by 2.4% in 2010 and Africa leads the world in production. Ghana recently reported a 43% increase in demand for it cocoa beans in the first weeks of 2011. Investors can bet on these nations via the Market Vectors Africa Index ETF (NYSE:AFK) and iShares MSCI Switzerland Index (NYSE:EWL).

The Bottom LineCocoa represents an interesting long-term option. Following a similar demand trend as many other popular commodities, cocoa should be considered as a portfolio play. The previous funds and stocks like Tootsie Roll Industries (NYSE:TR) offer a way for investors to tap into that growing demand.(For related reading, also take a look at Trading The Soft Commodity Markets.)